Lumber Liquidators (LL) rallied almost 4% Monday, helping shares escape a few boring weeks for the hardwood flooring company. More importantly, though, the move was technically sound, breaking LL stock out of a tight pattern — and now, Lumber Liquidators should offer active investors and traders a good-risk/reward opportunity to play the bounce.

On July 11, I discussed a potential oversold bounce trade in LL stock, and that finally triggered thanks to yesterday’s rally. As such, I’d like to revisit the trade idea, as well as the current technical picture and risk/reward profile.

Recall that in early July, Lumber Liquidators issued a major profit warning that led LL stock to drop sharply on July 10. Technically speaking, the vertical dropoff in LL came after it had already been trending lower for seven months, thus alerting me with at least near-term oversold signals.

LL Stock Charts

On the two-year chart below, note that the early July selloff brought LL stock back to its 61.8% Fibonacci retracement line of the entire rally from 2011 up to late 2013. Through a multiyear technical lens, this is an important support line for the stock, and so far this has held.

On the daily chart, note that after the big drop in early July, LL stock just trotted sideways for a few weeks. Even when Lumber Liquidators reported earnings on July 30, the stock didn’t budge much and held its July support line around $53.30.

After a big drop like LL stock saw in July — which left it much oversold and extended below its near-term moving averages — stocks tend to either consolidate sideways for a while or quickly bounce. Both types of price action can work off the near-term oversold readings in a stock, but LL stock chose to do the former (i.e., consolidate in time rather than in price).

For LL stock, note that while price just moved sideways for a few weeks after the big selloff, momentum as shown by the relative strength indicator (RSI) steadily rose off the lows, thus flashing positive divergence, which is bullish.

Monday’s rally cleanly broke LL stock higher and out of the multiweek consolidation phase. For now, active investors and traders can treat this as an oversold bounce rather than an absolute long-term low to lean against.

Lumber Liquidators has plenty of upside potential as it works into the empty space left behind on the chart by the July drop-off. If Monday’s upside momentum can sustain, then a first upside target in the $60-$62.50 area should be reachable in coming weeks. However, any sharp reversal of Monday’s jolt should be taken seriously.

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